Regulation (REG) AICPA Released Questions 2021 Answer

Regulation (REG)

AICPA

Released Questions –

2021

Answer Explanations

Multiple Choice Question #1: The correct answer is (c) A practitioner cannot unreasonably delay the prompt disposition of any matter before the Internal Revenue Service. The representative/practitioner should not in any manner delay or hinder the IRS examination, collection, or investigation by failing to produce the necessary information, after repeated requests. This applies to the practitioner while responding to the client as well as to IRS personnel. Practitioners also cannot advise a client to submit any document to the IRS for the purpose of delaying or impeding the administration of the Federal tax laws. Options (a), (b) & (d) are incorrect based on the above explanation. Multiple Choice Question #2: The correct answer is (a) Tax preparers who prepare federal income tax returns are subject to federal statutory liability and a

penalty may be assessed by the IRS if a preparer fails to sign a tax return. The penalty for failure to sign a

tax return is $50 per return up to $27,000 per year.

Option (b) is incorrect because the preparer made the mistake unknowingly and without the intention

to deceive; the amount of misstatement is also clearly trivial

Option (c) is incorrect because, according to the Statement on Standards for Tax Services, members can

recommend a position which has a realistic possibility of it being sustained.

Option (d) is incorrect because preparers may rely on information provided by the client without

verification unless it is clearly incorrect or incomplete. However, reasonable enquiries must be made

about the existence. Hence no penalty might be assessed.

Multiple Choice Question #3:

The correct answer is (c)

A member in public practice shall not disclose any confidential client information outside of the CPA firm

without specific consent of the client including work papers or audit documentation created by the CPA

during the course of the audit. Information cannot be shared with other CPAs or be given to third

parties, no professional courtesy.

Option (a) and (b) is incorrect because disclosure of information in the tax returns is not a violation.

Option (d) is incorrect because work papers may be disclosed without client consent to subpoena or

summons from valid judicial authorities, quality review, inquiry by AICPA or investigation authorized by

AICPA or CPA society or State Board of Accountancy (Mnemonic: IRIS)


The correct answer is (a)

An agent’s apparent authority can be terminated due to a provision of law and without notice under the

following circumstances-

1) Death of principal or agent (does not affect contracts made before death)

2) Insanity of principal

3) Bankruptcy of the principal

4) Subject of the agreement becomes illegal or impossible

Note- termination of an agency relationship by operation of law, applies to both actual and apparent

authority.

Option (b), (c) and (d) are incorrect as those might not always lead to the termination of apparent

authority.



The UCC Sales Article (Article 2) applies to all contracts involving sale of goods (tangible personal

property) derived from statutory law either by merchant or non- merchant.

However, the following are governed by common law

• Real estate

• Insurance

• Service and

• Employment (mnemonic RISE)

Therefore, only the sale of a used car by a non-merchant comes under the purview of UCC Article 2 (sale

of goods).

Option (a) is incorrect because sale of stock is governed by the Securities Act of 1934

Option (b) is incorrect because service is covered by common law

Option (d) is incorrect because sale of real estate is governed by common Law, specifically property law



No government approval is needed in the creation of a general partnership and there are no specific

filings required. A general partner has:

• Unlimited liability.

• Fiduciary duties towards the partnership.

• Responsibility for the day-to-day operations and decision making.

Option (b) is incorrect because the partners in a general partnership have unlimited liability

Option (c) is incorrect because under RUPA, withdrawal, death and bankruptcy of a partner doesn't

automatically dissolve the partnership. However, withdrawal, death and bankruptcy of all partners

leaving one leads to dissolution. Hence, partnership doesn't have perpetuity.

Option (d) is incorrect because a partnership cannot raise capital through issuance/sale of common

stock.



The transaction represents a wash sale. A wash sale exists when a security is sold for a loss and is

repurchased within 30 days before or after the sale date. This loss cannot be deducted, but is added to

the basis of the repurchased asset.

Since the taxpayer sold Core Co. shares on June 10th, within 30 days of purchasing it on May 15, the

$8,000 loss (i.e., $10,000 Selling Price - $18,000 Purchase Price) cannot be deducted.

Options (b), (c) and (d) are incorrect based on above explanation



In general, all gains from related party transactions are taxed but no loss is deductible. Related parties

include but not limited to spouses, siblings, children, grandchildren, majority partner in a partnership

and majority shareholder in a corporation. Since Hull is a 60% partner in a partnership, Hull and the

partnership are considered related parties. As such, the $12,000 loss realized on the sale of stock to the

partnership cannot be recognized as a capital loss.

Option (b) is incorrect because $3,000 is the maximum allowable net capital loss that individuals can

offset against other income. Since the transaction in question is considered a related party transaction,

no loss is recognized.

Option (c) is incorrect based on the above explanation.

Option (d) is incorrect because $12,000 is the loss realized and not the recognized loss.


The correct answer is (b)

Taxes may be owed by those who transfer large amounts of their wealth to others during their lifetime

and upon their death, based on the unified transfer tax. Transfers made during their lifetime are

reported on gift tax returns (Form 709) and upon death on estate tax return (Form 706) – This estate tax

return combines all reported gifts and value of the estate at death to determine if any additional taxes

are due.

The taxable gift amount each year is calculated as gross gifts (Cash / FMV) less non-discretionary and

discretionary expenses along with annual exclusions. The non-discretionary exclusion includes marital

and charitable deductions. The annual provisions have increased the annual exclusion amount to

$30,000 for married filing jointly ($28,000 as per prior law) and $15,000 for single taxpayers ($14,000 as

per prior law).

Therefore, from the list provided, only standard deduction is excluded while calculating the amount of

taxable gifts.

Option (a) is incorrect because of the above explanation.

Option (c) is incorrect because there is a gift tax annual exclusion up to $15,000 for single taxpayers and

$30,000 for married filing jointly.

Option (d) is incorrect because marital deduction of 100% is allowed in gift tax calculation.


The correct answer is (d)

Business income and expenses for self-employed individuals are reported on Schedule C. In general, any

expenses that are illegal are non-deductible and any federal, state and local fines and penalties are also

non-deductible. However, for businesses that are illegal, only the cost of goods sold is allowed as a

deduction, but all income is reported.

Particular Amount

Income-commission $100,000

Less-Expenses:

Auto rentals (2,000)

Referral fees to other brokers

(20,000)

Total Income $78,000

Options (a), (b) and (c) are incorrect because both parking fines and the illegal referral fees are non-

deductible against income on Schedule C.



Investment interest expense up to the extent of taxable investment interest income is deductible.

Jefferson has taxable interest income of $2,000 from a treasury bond and non-taxable/tax-exempt

interest income of $1,000 from a municipal bond. Hence, he can deduct up to $2,000 of investment

interest expense to the extent of taxable interest income from the treasury bond.

Option (a) is incorrect because $1,000 is the interest income from municipal bond which is non-taxable.

Option (c) is incorrect because $3,000 is the total interest income, not the allowable deduction.

Option (d) is incorrect because $4,000 is the total interest expense incurred.



Passive activity losses are generally offset against passive activity income. Any remaining losses are

suspended and carried-forward indefinitely until fully utilized or complete disposal of passive activity.

Option (a) and (b) is incorrect because of above explanation

Option (d) is incorrect because the carried over loss also retains its original structure and can be offset

only against passive income



According to the at-risk rules a partner's deduction of partnership loss is limited to the amount by which

the partner is at-risk in the business. The amount at-risk is generally equal to the cash and/or adjusted

basis of property contributed and recourse loans. and it can be carried over to future Years

Option (a) is incorrect because Partner includes his share of Partnership Capital gain in his 1040 in

Schedule D and is not treated as ordinary income

Option (c) is incorrect because Passive activity loss rules states that passive losses can be used only to

offset passive income

Option (d) is incorrect because in general, a partner's distributive share of partnership loss (including

capital loss) is allowed only to the extent of the adjusted basis of such partner's interest in the

partnership (outside basis) at the end of the partnership year in which such loss occurred.



In a liquidating distribution, the outside basis of the distributee partner must be allocated to all of the

assets received in the distribution. Basis is always allocated first to money. The basis allocated to the

other property distributed to a partner is generally a carryover basis from the partnership’s inside basis.

In the event, a partner’s outside basis exceeds the basis necessary to give a carryover basis, then the

basis of the assets other than unrealized receivables and inventory is increased. The bases of hot assets

(inventory and unrealized receivables) distributed to a partner are always limited to the basis the

partnership had in those assets prior to the distribution. If the distribution consists only of money,

unrealized receivables, and inventory, then the partner recognizes a loss.

As per the above rules, the computation of bases can be illustrated as follows:

Item Amount

Partner's Basis (Outside Basis) $25,000

Cash Distribution (12,000)

Partner's Basis before property distribution

13,000

Land Distribution (Adjusted Basis $8,000) (13,000)

Partner's net basis $0

Gain or Loss to be recognized $0

Note: Since unrealized receivables must take on the carryover basis of the partnership and the

partnership had a zero adjusted basis in them, A/R would continue to have zero basis in the hands of the

partner.

Option (a) is incorrect because it is the FMV of A/R and Land.

Option (c) is incorrect because the basis of A/R is $0.

Option (d) is incorrect because it is the adjusted basis of land before considering liquidation rules


The correct answer is (a).

For a corporation, capital losses are allowed in the current tax year only to the extent of capital gains. A

net capital loss can be carried back 3 years and forward up to 5 years as a short-term capital loss. In Year

1, they incurred net $50,000 loss (300,000-250,000) which is carried over. In Year 2, there was a Net

Gain of $75,000(425,000-350,000).

The Corporation can set off the $50,000 loss of Year 1 in Year 2, resulting in an overall gain of $25,000

(75,000-50,000).

Option (b) is incorrect because it is the total capital loss in Year 1

Option (c) is incorrect because, it is the net gain in year 2.

Option (d) is incorrect because it is the gain incurred in Year 2 before any prior year losses are set off.



Only entities organized in the United States and treated as corporations may file a consolidated federal

income tax return. The return is filed by a “common parent” and only those subsidiaries in which the

common parent owns 80% or more of the vote AND value. When an individual owns more than 80% or

more of the stock of 2 or more corporations, then, such corporations are treated as brother-sister

corporations and consolidation if not allowed. Each sister company operates independently from the

others, and in most cases, they produce unrelated product lines.

Since all three companies are sister corporations none can file a consolidated return.

Options (a), (b) and (c) are incorrect based on the above explanation.



S-Corps are pass-thru entities that pass income to the shareholders proportionate to their interest in the

corporation and the shareholders pay taxes on that income at the individual level.

Shareholder's basis in S Corp. is computed as follows:

Initial Basis (cash and property contributed)

Add: Separately & non-separately stated income items

Less: Distributions

Less: Non-deductible expenses

Less: Deductible expenses

Less: Losses

Net Basis

B has equal share as A; hence the computation is as follows:

13,000(Initial Basis) + 50,000(50% of ordinary income) + 2,500(50% of tax-exempt income) -

50,000(distribution) = $15,500 Basis

Options (b), (c) and (d) are incorrect based on above calculation.



The amount of partnership loss that can be deducted on a partner’s tax return is limited to his “at risk”

amount in respect of such partnership. In other words, the adjusted basis of the partner taxpayer cannot

be reduced below zero. The amount “at risk” also refers to the partner’s basis in the partnership which

is partner’s equity/capital + share of partnership liabilities.

Partner’s basis increases as a result of each of the following:

• Contributions made by partner

• Share of partnership income

• Borrowings and other debts incurred by the partnership

Partner’s basis is reduced by the following (in the order provided):

• Distribution of assets by partnership (reduction in debt, is also treated as distribution to partner)

• Share of partnership losses

• Distributive share of non-deductible expenses

Year 1

Basis in the beginning $10,000

Loss deductible (15,000)

Basis at end of the Year 0

Year 2

Basis in the beginning $0 ($5,000 carried over from Year 1)

Gain 3,000

Basis at end of the Year 0

Year 3

Basis in the beginning $0 ($2,000 carried over from Year 1)

Gain 5,000

Basis at end of the Year 3,000

Share of the partnership loss/gain is 50% for each Partner. However, the loss deductible is limited such

that the basis does not reduce below zero. Therefore, a loss of only $10,000 in Year 1 is deductible the

remaining loss of $5,000 is carried forward and utilized when there is additional basis to absorb the loss

or when the partnership interest is disposed of i.e. in Year 2 and 3 Respectively.

Options (a), (b) and (d) are incorrect based on above calculation.



A partner’s basis in a partnership is generally equal to the adjusted basis of cash and/or property

contributed plus a percentage of partnership liability. Each partner’s basis is increased for the pro rata

share of partnership liability to determine the "at-risk" basis.

Therefore, when a partner's share of partnership liability increases, it also increases the basis of the

partner.

$40,000 (Beginning basis) + $50,000(40% of $125,000 liability) = $90,000(ending basis.

Option (a) is incorrect because it has subtracted the liability increase instead of adding it to the basis.

Option (b) is incorrect because of the above calculation.

Option (c) is incorrect because it is the initial basis of A without making any adjustment for A’s share of

partnership’s liabilities.



Upon rejection of the IRS audit conclusions by the taxpayer, the IRS sends a copy of examination report

and preliminary notice (30-days letter). The taxpayer then has 30 days to either accept the deficiency or

request administrative appeals with an appeals officer.

Option (b) is incorrect because there is no practice of immediate collection.

Option (c) is incorrect because only when there is no acceptance of the deficiency or request to

administrative appeals with an appeals officer, notice of deficiency (90-day letter) is issued.

Option (d) is incorrect because this occurs in the later stages.



Treasury regulations are the U.S. Department of Treasury’s interpretation of the IRC. They give

directions on how to apply the law outlined in the IRC and have the second most force and effect

(second only to IRC). On the other hand, a private letter ruling or PLR, is a written statement issued to a

taxpayer that interprets and applies tax laws to the taxpayer’s represented set of facts. A PLR is issued in

response to a written request submitted by a taxpayer. A PLR may not be relied on as precedent by

other taxpayers or by IRS personnel. Since the PLR here is inconsistent with subsequent treasury

regulations it cannot serve as substantial authority.

Options (a), (b) and (c) constitute substantial authority to the taxpayer’s position.



When liability for negligence is brought on by a client, the plaintiff must prove the following (Mnemonic:

Material LIE):

• Material misstatement or omission in the financial statements.

• Loss (damages) - plaintiff suffered a financial loss.

• Information in the financial statement was the proximate cause of the harm to the plaintiff.

• Error was caused by breach of duty of care.

As such, the best defense for a CPA to avoid the liability would be that the CPA's negligence was not the

proximate cause of the client's losses.

Option (a) is incorrect because actual fraud was lacking is not a defense to be used in a suit for

negligence.

Option (c) is incorrect because even if client was contributorily negligent, the CPA would still be liable for

their negligence.

Option (d) is incorrect because scienter (reckless misconduct or intent to deceive) must be proved in

cases of actual fraud. This is a suit for negligence and scienter is not required.



An anticipatory breach is one wherein one party informs the other regarding the non- performance of a

contract prior to the due date. Since the construction company informed the business of their non-

performance by July 1, it is considered an anticipatory breach. The business can consider the

construction company in breach by July 1 and immediately seek remedies, they need not wait until the

contract performance deadline of October 1.

Option (b) is incorrect because the company is entitled to immediate remedial measures

Option (c) is incorrect because the breach occurred on July 1st and the company need not wait until

October.

Option (d) is incorrect as the Company is entitled to immediate remedial measures and they need not

serve any 30-day notice to the construction company.



When a person agrees to be a surety or co-signer, the creditor is permitted to treat them as debtor and

demand payment without any proof of default by the principal debtor, making them primarily

responsible to the creditor.

Option (b) is incorrect because the surety does have the right to subrogation to collect the debt.

Option (c) is incorrect because the creditor may use wage garnishment but there is no criteria that they

must use only that method.

Option (d) is incorrect as per above explanation.



Under the Revised Uniform Partnership Act, in the absence of a partnership agreement a unanimous

vote by all partners is required for the approval of any extraordinary transaction. As such, the

partnership in this case would need all seven votes.

Option (a), (b) and (c) are incorrect based on the above explanation.



Generally, assets received as gift retain the net book value on donor's books. (i.e., rollover cost+ rollover

period) plus any gift tax paid due to appreciation in the value of gift. As such, the gift received by the

taxpayer will have the donor's rollover cost as long as the FMV of the property is greater than the

donor's basis on the date of gift. When the taxpayer disposes the property, gain on the sale is calculated

as sale price of $9,000 minus the donor's basis of $4,500 (i.e., $9,00 - $4,500). Since, even holding period

is rolled over, it would be a long-term gain.

Option (a) is incorrect because gain is calculated as difference between selling price and FMV at the time

of gift received.

Option (b) is incorrect because gain is calculated as difference between selling price and FMV at the time

of gift received by rolling over the holding period.

Option (c) is incorrect because even the period of holding is rolled over along with the basis.



The gain from involuntary conversion of a property (by destruction or theft/condemnation/federally

declared disaster area) can be deferred by a taxpayer if the property is replaced within the statutory

period established by law. The time limit, which is measured from the calendar year in which insurance

proceeds are received, is 3 years for government condemnation, as in the case of this taxpayer.

The realized gain resulting from involuntary conversion is $25,000 ($100,000 government compensation

– $75,000 adjusted basis of the property converted). As the taxpayer reinvested all $100,000 of the

proceeds received, within the statutory time frame (3 years from the calendar year the taxpayer

received the proceeds), he need not immediately recognize $25,000 as gain. His basis in the

replacement property is $75,000 ($100,000 cost of replacement property - $25,000 deferred gain).

Option (b) is incorrect because basis for property is reduced by the deferred gain and is not the actual

purchase price

Option (c) is incorrect because taxpayer is eligible to defer the $25,000 gain.

Option (d) is incorrect because no gain needs to be recognized.



For assets received as inheritance, the recipient's basis is generally equal to the FMV at date of death

unless an alternative valuation date is elected. The holding period of the asset for recipient is always

long term, irrespective of how long the property was held by the decedent. Madison's basis in the

property that she inherited from her parent, upon their death, is equal to the FMV at death of $200,000.

The holding period in the investment property is long-term irrespective of how long her deceased

parent held it. Therefore, when Madison sold the property for $150,000, she realized a long-term loss of

$50,000 ($150,000 - $200,000) which must be recognized.

Options (a), (b) and (c) are incorrect because Madison incurred a loss of $50,000 which is long-term in

nature



Rental income of $15,000 is the only passive income which is reported on Schedule E among all the

choices provided. Dividend income is considered portfolio income which is reported on Schedule B.

Likewise, capital gains and losses are characterized separately as capital income that is generated upon

sale capital assets.

Options (a), (c) and (d) are incorrect based on the above explanation.



The taxpayer’s adjusted gross income is calculated as follows:

Salary $122,000

Add: Capital gain dividends 3,700

Less: Partnership short-term capital loss (2,750)

Adjusted Gross Income $122,950

Note- The partnership loss is deductible only to the extent of basis.

Options (a), (b) and (c) are incorrect based on above explanation.



Two rules which must be satisfied to qualify as “head of household” are:

Rule #1: Taxpayer must be unmarried / married but separated for over six months at year end / non-

qualifying widow(er), and

Rule #2: Dependent(s) (dependent child, dependent parent and / or dependent relative) lives at

taxpayer’s home (or household) for over half year and taxpayer provides for > 50% of costs of

maintaining the household.

Only Option A does not satisfy the condition as the taxpayer qualifies for Qualifying Widow/'er.

Options (b), (c) and (d) all satisfy the conditions and are qualified to file as Head of Household



The Net Investment Income Tax (NIIT) is imposed by section 1411 of the Internal Revenue Code. The

NIIT applies at a rate of 3.8% to certain net investment income of individuals, estates and trusts that

have income above the statutory threshold amounts.

In general, investment income includes, but is not limited to: interest, dividends, capital gains, rental

and royalty income, non-qualified annuities, income from businesses involved in trading of financial

instruments or commodities and businesses that are passive activities to the taxpayer. The tax is

triggered when investment income exceeds the threshold amounts noted below for the respective filing

statuses.

Filing Status Threshold amount

Married Filing Jointly $250,000

Married Filing Separately $125,000

Single $200,000

Head of household (with qualifying person) $200,000

Qualifying widow(er) with dependent child $250,000

Option (b) is incorrect because NIIT is not applicable to Corporations

Option (c) is incorrect because Non-Resident Aliens (NRAs) are not subject to the net investment income

tax.

Option (d) is incorrect because net investment income tax generally applies to estates and trusts. Trusts

that are treated as business entities, certain state-law trusts, tax-exempt trusts, and grantor trusts are

exempt from the tax, for example charitable trusts.



For a corporation, capital losses are allowed in the current tax year only to the extent of capital gains. A

net capital loss can be carried back 3 years and forward up to 5 years as a short-term capital loss. In the

Year 4, they incurred a loss of $438,000 which can be carried back to Year 3 and Year 2 to set off against

capital gains, which results in net loss of $410,000 ($438,000-$11,000 of Year 3-$17,00 capital gain of

Year 2) which would be carried over to future years for up to 5 years.

Note- In Year 2 the taxable income is $17,000 which is lower than the capital gain of $21,000, Hence the

deduction is allowed only to the extent of taxable income.

Option (a) is incorrect because it is calculated as $438,000-$11,000 of Year 1-$21,00 Capital gain of Year

2, which is incorrect.

Option (c) is incorrect because it is calculated as $438,000-$11,000 of Year 3 and ignores Year 2.

Option (d) is incorrect because it carries forward all the capital gain without considering the carryback

option.



Distributions made to its shareholders are made by the corporation in the following order:

i. Taxable dividend income, to the extent of higher of Current Earnings and Profits (CEP), or sum of

Current Earnings and Profits (CEP) and Accumulated Earnings and Profits (AEP) before

distribution

ii. Non-taxable return of capital, to the extent of shareholder’s basis and in excess of AEP and CEP

iii. Capital gain income, in excess of E&P and shareholder’s basis.



A corporation that conducts business in multiple states must determine the portion if its net income

that is subject to tax in each state. Apportionment is a means by which a corporation's business income

is divided among the states in which it conducts business using an approved formula. Each state uses

different number of factors to determine its share of income; though traditionally a three-factor formula

which equally weighs sales, property and payroll factor is used. Many states do use a modified three-

factor formula, where the sales factor is weighed more than the others:

Apportionment Factor %

Payroll 50%

Sales 25%

Property 75%

Total 150%

Average 150%/3 = 50%

Option (a) and (c) is incorrect because it is calculated incorrectly.

Option (d) is incorrect because it is the total & not the average apportionment percentage.



To voluntarily terminate an S corporation's status requires a vote by the shareholders. Any combination

of shareholders that make up 50 percent of the outstanding stock must be in agreement to terminate

the S corporation status.

There are ways an S corporation can be involuntarily terminated. One way is if any of the qualifications

required to become an S corporation are violated ("100 US Individuals are common").

In an S-Corp all Shareholders must be individuals (certain estates and trusts are also allowed), since

shares were issued to a partnership it leads to automatic termination of the status.

Option (a) is incorrect because certain estates and trusts are also allowed to be Shareholders.

Option (b) is incorrect because issuance of shares to a qualified profit-sharing plan is allowed.

Option (d) is incorrect because it can issue common stock with two series of same class.



There are certain transactions or events during the life of a partnership that can result in a divergence

between inside and outside basis which can result in incongruent tax treatment and the purpose of Sec

754 election is to align inside and outside basis to avoid these scenarios and is done by aligning the

partnership’s basis in those assets (inside basis) with the partner’s basis in the partnership assets

(outside basis).

The outside basis is the purchase price plus the share of partnership's liabilities assumed while the inside

basis is the incoming/outgoing partner's share of partnership’s inside basis of the assets ‘the basis

partnership itself has in its assets’. Inside basis comes from basis of assets contributed by the partners

plus basis of the assets purchased by the partnership from its own funds.

Following the rules here, outside basis in the partnership assets is $100,000 (Purchase price) and inside

basis is $25,000 (50% of $50,000). The basis adjustment as per Sec 743(b) is the difference between his

outside and inside basis i.e., $75,000 ($100,000 OB - $25,000 IB) and will be allocated only to the assets

which adds up to $175,000 (Asset basis $100,000+ $75,000 basis difference).

Options (a), (c) and (d) are incorrect based on above calculation.


The correct answer is (c).

In a trust, the income that is passed through to a beneficiary has the same tax attributes in the hands of

the beneficiary as when it is received by the trust, the nature of income generated doesn't get modified.

Option (a) is incorrect because the basis shall be the same as it would be in the hands of the grantor

increased in the amount of gain or decreased in the amount of loss recognized to the grantor.

Option (b) is incorrect because distributed income is taxed in the hands of receiver and not at trust level

avoiding double taxation

Option (d) is incorrect because trust doesn't have a flat rate instead, they have slab rate based on

certain threshold.

Simulation #1: Item: 500084

Row 2: $1,000 & No imprisonment -If a tax return preparer prepares any return or claim of refund with respect to which any part of an understatement of liability is due to a unreasonable position and the preparer knew (or reasonably should have known) of the position, such tax return preparer shall pay a penalty with respect to each such return or claim in an amount equal to the greater of $1,000 or 50 percent of the return prep fee. 50% of $1,250(Return preparation fee) is $625, since $1,000 is greater, the preparer is liable for $1,000.

Row 3: $5,000 & No imprisonment -Any tax return preparer who prepares any return or claim for refund with respect to which any part of an understatement of liability is due to wilful or reckless conduct shall pay a penalty with respect to each such return or claim in an amount equal to the greater of—$5,000, or 75 percent of the income derived (or to be derived) by the tax return preparer with respect to the return or claim. 75% of $1,250 (Return preparation fee) is $938, since $5,000 is greater, the preparer is liable for $5,000.

Row 4: $1,000 & No imprisonment-Any person, who aids or assists in, procures, or advises with respect to, the preparation or presentation of any portion of a return, affidavit, claim, or other document, who knows that such portion will be used in connection with any material matter arising under the internal revenue laws, and who knows that such portion (if so used) will result in an understatement of the liability for tax of another person, shall pay a penalty with respect to each such document in the amount of $1,000. In the case of a corporate taxpayer, the penalty imposed would be $10,000. Since this is an individual taxpayer, the penalty imposed shall be $1,000.

Row 5: $10,000 & 1 Year -Any person who wilfully delivers or discloses to the Secretary any list, return, account, statement, or other document, known by him to be fraudulent or to be false as to any material matter, shall be fined not more than $10,000 ($50,000 in the case of a corporation), or imprisoned not more than 1 year, or both.

Row 6: $100,000 & 3 Years- Any person who, willfully makes and subscribes any return, statement, or

other document, which contains or is verified by a written declaration that it is made under the

penalties of perjury, and which he does not believe to be true and correct as to every material matter

shall be guilty of a felony and, upon conviction thereof, shall be fined not more than $100,000 ($500,000

in the case of a corporation), or imprisoned not more than 3 years, or both, together with the costs of

prosecution.

Row 7: $0 & No imprisonment- An Accuracy-Related Penalty applies when a taxpayer underpays the tax

required to be shown on their return. Underpayment may happen if they don’t report all their income or

claim deductions or credits for which they don’t qualify. An amount equal to 20 percent of the portion

of the underpayment shall be added to the tax. However, this penalty only applies to the taxpayer and

not the tax return preparer, as such, the amount of fine is $0.

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Simulation #2:

Item: 500511

Step 1: Search - '' disallowance of loss” or “wash sale''

Step 2: Open - Internal Revenue Code > Subtitle A Income Taxes (§§1-1563) > Chapter 1 Normal Taxes

and Surtaxes (§§1-1400U-3) >Subchapter O - Gain or Loss on Disposition of Property (§§1001-1111)>

Part VII - Wash Sales; Straddles (§§1091-1092) > §1091 Loss from wash sales of stock and securities.

Correct Answer: IRC Sec 1091(d)

Simulation #3:

Item: 502063

A partnership is a pass-through entity acting as a conduit to pass through items of income, deduction

and credit to be reported on the tax returns of its partners. Partnership items having special tax

characteristics (e.g., passive activity losses, deduction subject to dollar or percentage limitations, etc.)

must be separately listed and shown on Schedule K and Schedule K-1 so that their special characteristics

are preserved when reported on partner’s tax returns. In contrast, partnership ordinary income and

deduction items having no special tax characteristic and can be netted together in the computation of a

partnership’s ordinary income or loss from trade or business activities on page 1 of Form 1065. A

partner’s basis for a partnership interest is increased by the flow-through of income (including non-

taxable income), and reduced by distributions, and the flow-through of deductions (including non-

deductible items).

In general, a partner's share of a recourse liability equals the portion of the debt for which the partner

"bears the economic risk of loss." A partner bears the economic risk of loss for what he would have to

pay if the partnership's assets become worthless and its liabilities are immediately payable. A partner

may also have the economic risk of loss for his/her obligation to make an additional contribution to

cover a partnership liability or from an obligation to pay the creditor directly in the event of a

partnership default.

A limited partner generally does not bear the economic risk of loss for any partnership liability unless

the partner is obligated to make further contributions to the partnership or has made a special

agreement to pay a creditor or another partner directly in the event of a partnership default. Hence no

debt is allocated to them.

1. 55,200 - Ordinary income of a partnership is calculated by deducting from the business net

receipts, ordinary and necessary deductions like COGS, rent, salary, etc.

The calculation can be illustrated as follows:

Description (Corresponding line number on Form 1065)

Amount

Sales less returns and allowances (Line 1c) $455,000

COGS (Line 2) (117,000)

Gross Profit (Line 3) 338,000

Salaries & Wages (Line 9) (192,000)

Depreciation Expense (Line 16 - MACRS depreciation flows through from Form 4562)

(26,000)

General and administrative expenses (Line 20) (20,000)

Real estate taxes (Line 14) (6,000)

Interest Expense-Midland bank (Line 15) (2,000)

Ordinary Business Income (Line 22) $92,000

From the income statement, charitable contributions, bank interest income and capital loss on

sale of land are not included in the computation of net ordinary business income as these are

separately stated items that flow through to the individual shareholders separately on the K-1.

The purpose of separately stating items is to allow any special treatment on individual returns to

be applied. As a general rule, tax law excludes any fine or penalty paid to the government as a

business deduction.

Green’s Share is 60%, hence his share of ordinary income will be 60%*92,000=$55,200.

2. $400 - There is one separately stated item on the income statement and it is Interest income. As

previously stated, the purpose of separately stating is to ensure that any limitations that may

apply on the individual tax return are taken in to account.

Accordingly, since Smith is a 40% holding Partner, he reports his share of 40%*1,000=$400.

3. $46,000 - Bank loan worth $50,000 was borrowed to purchase equipment. In the trial balance

we see the current portion ($6,000) and the long - term portion ($40,000) outstanding add up to

$46,000.

Since, Smith is a limited partner and the facts provided indicate this is a recourse liability, 100%

of the debt is allocated to Green.

4. $0 - A limited partner generally does not bear the economic risk of loss for any partnership

liability unless the partner is obligated to make further contributions to the partnership or has

made a special agreement to pay a creditor or another partner directly in the event of

partnership default. Hence no debt is allocated to Smith.

5. $25,000 - Accounts Payable worth $25,000 is allocated entirely to Green as Smith is a limited

liability partner.

6. $0 - See answer explanation for 5.

7. $0 - The loan of $15,000 is loaned by partner Smith entirely. Hence, the entire loan basis is

allocated to Smith accordingly.

8. $15,000 -The loan of $15,000 is loaned by the partner Smith entirely. Hence, the entire loan

basis is allocated to Smith accordingly.

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